UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Release No. 34-36855 / February 16, 1996
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 760 / February 16, 1996
ADMINISTRATIVE PROCEEDING
File No. 3-8920
__________________________
:
In the Matter of :
: ORDER MAKING FINDINGS AND
AMERICAN AIRCRAFT : IMPOSING A CEASE ANDDESIST
CORPORATION : ORDER BY DEFAULT
:
_________________________:
The Division of Enforcement ("Division") has filed a motion
for default in this matter. In support of its motion, the
Division states that the Order Instituting Public Administrative
And Cease And Desist Proceedings And Notice Of Hearing Pursuant
To Section 21C of The Securities Exchange Act of 1934 ("Order")
was issued on January 11, 1996, and served on Respondent American
Aircraft Corporation ("AAC" or "Respondent") that same day. More
than twenty days have elapsed since the Order was served on AAC
and no answer has been received from it.
As provided by Rules 155 and 220 of the Commission's Rules
of Practice, 17 C.F.R. 201.155 and 201.220, AAC is hereby
deemed to be in default, because it has not answered the Order.
Furthermore, AAC's counsel stated to counsel for the Division
that AAC did not object to entry of default.
Accordingly, I find the following allegations, as set forth
in the Order, to be true:
A. THE RESPONDENT
AAC was primarily engaged in developing vertical flight
aircraft but had not succeeded in selling any of its aircraft.
AAC's common stock was quoted on the National Association of
Securities Dealers Automated Quotation System ("NASDAQ") until
April 1993, when it was delisted for failure to meet asset,
equity and bid price requirements. On December 20, 1994, AAC
voluntarily filed for Bankruptcy under Chapter 11 (Bankr. N.D.
Cal. Case No. 94-12938). On August 14, 1995 AAC converted its
Chapter 11 Bankruptcy to Chapter 7. Charles Sims is AAC's court
appointed trustee for the Chapter 7 proceeding and had no
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affiliation with AAC prior to September 1995.
B. BACKGROUND
On March 4, 1988, AAC, a public company, and Phalanx
Organization, Inc. ("Phalanx"), a private company, completed a
reverse acquisition in which AAC acquired Phalanx's operations
and management. As a result of the acquisition, Phalanx's
president and controlling shareholder became president and CEO of
AAC (the "President"). After the acquisition, AAC was reportedly
developing several aircraft capable of vertical flight. In
August 1990, AAC suspended all development work except for the
Penetrator helicopter, which was a material modification of an
existing UH-1 Huey helicopter. In 1991, AAC completed
construction of a single pre-production prototype of the
Penetrator helicopter, which has not yet completed testing.
AAC and its officers and employees had little or no
expertise in accounting or Generally Accepted Accounting
Principles ("GAAP"). AAC's bookkeeper told the President in
December 1988 that the President should hire a capable accountant
who could properly prepare AAC's financial statements. The
President did not hire such an accountant. As described below,
during fiscal years ended November 30, 1988 through November 30,
1991, AAC valued certain aircraft designs (the "Designs"), which
in fact had no reportable value, as assets under GAAP, and
capitalized as assets certain research and development ("R&D")
costs that should have been expensed. As a result, AAC
materially overstated its assets in amounts ranging from
$5,509,069 to $7,097,332 and materially understated its net
losses in amounts ranging from $366,062 to $1,153,829 for fiscal
years 1988 through 1991 in interim and annual financial
statements filed with the Commission in Forms 10-Q and 10-K.
C. AAC MATERIALLY OVERSTATED THE VALUES OF ITS ASSETS
1. The Designs
The President, then affiliated with Phalanx, developed the
Designs, with virtually no monetary investment, between July 1987
and February 1988. AAC, as part of the AAC-Phalanx reverse
acquisition, acquired the Designs from the President for 2.5
million AAC restricted shares on February 17, 1988. Under GAAP,
AAC was required to report the Designs at the President's basis,
which was zero, because AAC acquired the Designs from the
President in connection with a reverse acquisition. See
Accounting Principle Board Opinion No. 16, 70; see also Staff
Accounting Bulletin Topic 2.A.
Instead, from its second quarter fiscal 1988 Form 10-Q
through its fiscal 1991 Form 10-K, AAC reported the Designs as
assets valued at $4,687,500 before amortization. As a result,
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the Designs represented at least 50% of AAC's total assets in
each filing. In fact, GAAP required that AAC report the Designs
as having a zero value. As a result of attributing a value to
the Designs, AAC materially overstated its total assets in its
Forms 10-K and 10-Q from the second quarter of its fiscal 1988
through the end of its fiscal 1991.
In improperly valuing and recording the Designs as an AAC
asset at $4,687,500, AAC used 50% of the then NASDAQ quoted $3.75
per share price of its own common stock to value the 2.5 million
shares exchanged.
2. The R&D Costs
AAC, during fiscal years 1988 through 1991, improperly
capitalized certain R&D costs as tooling and inventory assets.
GAAP requires that R&D costs be expensed as incurred. FAS 2,
12. AAC falsely represented in its Forms 10-K and 10-Q that AAC
expensed R&D costs when incurred. As a result of improperly
capitalizing R&D costs, from fiscal year 1988 through 1991, AAC
materially overstated its assets by amounts ranging from
approximately $821,569 to $3,288,738 and materially understated
its net losses by amounts ranging from approximately $366,062 to
$1,153,829.
a. The Tooling
For fiscal years 1988 through 1991, AAC improperly reported
as assets tooling costs related to its preproduction prototypes.
AAC's auditor told the President, prior to AAC filing its Forms
10-K with the Commission, that the tooling costs, as well as the
prototype costs discussed below, were R&D and should have been
expensed. The President nevertheless signed management
representation letters to AAC's auditor stating that the tooling
was properly capitalized because the projects related to the
tooling were beyond the R&D stage. Contrary to the management
letter representations, AAC disclosed in its 1990 and 1991 Forms
10-K that it had not in fact completed development of any of its
proposed products. Nevertheless, in its Forms 10-K for fiscal
years 1988 through 1991, AAC materially overstated its assets by
reporting tooling costs as assets at amounts ranging from
approximately $776,350 to $1,228,711, net of amortization. AAC's
reporting the tooling as assets rather than expenses also
resulted in it materially understating its net losses in Forms
10-Q and 10-K for fiscal years 1988 through 1991 in amounts
ranging from approximately $315,000 to $862,649.
b. The Prototype
During its fiscal years 1990 through 1991, AAC capitalized
certain costs related to the manufacture of prototypes. AAC
disclosed in its fiscal 1991 Form 10-K that since January 1990,
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it had been developing the Penetrator helicopter, consisting of
major technological modifications to the obsolete UH-1 Huey
helicopter. AAC's fiscal 1991 Form 10-K further disclosed that
AAC had produced a single Penetrator, a "proof of concept"
version, that would be disassembled and analyzed at the
completion of test flights.
AAC improperly reported preproduction prototype development
costs as inventory assets in its Forms 10-K and 10-Q for fiscal
years 1990 and 1991 in the amounts of $998,618 and $2,512,388,
respectively. As a result of capitalizing these costs, AAC
materially understated net losses for fiscal years 1990 and 1991
by $948,618 and $1,563,770 respectively.
D. AAC VIOLATED THE FEDERAL SECURITIES LAWS
1. AAC violated Section 10(b) of the Securities Exchange
Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder in that
it, by engaging in the conduct described in Section C. above, in
connection with the purchase or sale of securities, directly or
indirectly, by the use of means or instrumentalities of
interstate commerce, or of the mails, or of the facilities of a
national securities exchange, with scienter:
a. employed devices, schemes or artifices to defraud;
b. made untrue statements of material fact or omitted
to state material facts necessary in order to make
the statements made, in the light of the
circumstances under which they were made, not
misleading; or
c. engaged in acts, practices, or courses of business
which operated or would operate as a fraud or
deceit upon other persons.
2. AAC violated Section 13(a) of the Exchange Act and
Rules 12b-20, 13a-1 and 13a-13 thereunder in that it, by engaging
in the conduct described in Section C above, filed with the
Commission annual reports on Commission Form 10-K and quarterly
reports on Commission Form 10-Q for the periods ending February
29, 1988, through November 30, 1991, which reports contained
untrue statements of material fact and omitted to state material
facts necessary in order to make the statements made, in the
light of the circumstances under which they were made, not
misleading.
3. AAC violated Section 13(b)(2) of the Exchange Act in
that it, by engaging in the conduct described in Section C.
above:
a. failed to make and keep books, records, and
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accounts, which, in reasonable detail, accurately
and fairly reflected the transactions and
dispositions of its assets; and
b. failed to devise and maintain a system of internal
accounting controls sufficient to provide
reasonable assurances that transactions were
recorded as necessary (i) to permit preparation of
financial statements in conformity with generally
accepted accounting principles or any other
criteria applicable to such statements, and (ii)
to maintain accountability for assets.
Based on the foregoing, I find that it is in the public
interest to sanction AAC pursuant to Section 21C of the Exchange
Act.
IT IS HEREBY ORDERED, pursuant to Section 21C of the
Exchange Act, that: AAC cease and desist from committing or
causing any violations and any future violations of Sections
10(b), 13(a) and 13(b)(2) of the Exchange Act and Rules 10b-5,
12b-20, 13a-1 and 13a-13 thereunder.
______________________________
Lillian A. McEwen
Administrative Law Judge
SERVICE LIST
Securities and Exchange Commission
Division of Enforcement
Branch of Regional Office Assistance
Mail Stop 4-8B
Attn: Laurie E. Stewart
450 Fifth Street, N.W.
Washington, D.C. 20549
American Aircraft Corp.
c/o Mr. Charles Sims
Court Appointed Chapter 7 Trustee
37 Old Courthouse Square
Santa Rosa, CA 95404
Steven Olson, Esq.
Gary, Shea, O'Donnel and Grattan
P.O. Boc 429
Santa Rosa, CA 95404
Karen Matteson, Esq.
Roger D. Boudreau
Securities and Exchange Commission
5670 Wilshire Blvd., 11th floor
Los Angeles, CA 92103